SEC files new charges against Cabletron, Enterasys execs

Published: February 13, 2007

The Securities and Exchange Commission has filed civil charges of securities fraud against 10 former Cabletron Systems and Enterasys Networks officials, including former Chief Executive Officer Piyush Patel and former Chief Financial Officer David Kirkpatrick.
The 51-page complaint alleges that the officials conspired to inflate revenue through numerous deals dating back to March 2000 -- more than a year before the Rochester-based Cabletron spun off Enterasys.
The officials allegedly often concealed secret side agreements and used phony investments to sell products to companies that didn’t need them, couldn’t pay for and intended to return. They allegedly concealed all this from the auditors, causing the company to overstate earnings by as much as 600 percent.
According to the charges, Patel, 49, of New Hampton, Kirkpatrick, 54, of Portsmouth and Eric Jaeger, 43, of Madbury - the former senior vice president of corporate affairs -- not only often knew what was going on, and reaped substantial profits from it, they directed the operation and participated in some of the deals directly, according to the complaint.
Other defendants include former Enterasys comptroller Lawrence Collins, 55, of Cape Elizabeth, Maine, and Michael Skubisz, 39, of Durham, former CEO and president of another Cabletron spinoff, Aprisma.
Also named are the five former Enterasys officials recently tried on criminal charges in U.S. District Court in Concord on some of the same allegations detailed in the complaint. They are Robert Gagalis, 47, of Rye, former Enterasys CEO; Bruce Kay, 54, a Cabletron comptroller who went on to work as CFO and senior vice president of finance at Enterasys; Jerry Shanahan, 41, of County Cork, Ireland, an executive vice president of operations at Cabletron and chief operating officer of Enterasys; Robert Barber, 54, executive vice president of corporate affairs at Enterasys; and David Boey of Alpharetta, Ga., vice president of Enterasys’s Asia Pacific region.
In December, a jury convicted four of the five former Enterasys executives, who are awaiting sentencing in April. The jury couldn’t reach a decision on Shanahan, and federal prosecutors have yet to decide whether to retry him.
The jury found that several of the criminal defendants participated in “three-corner deals,” in which Enterasys would invest in shaky companies so the companies would buy Enterasys products through a distributor in order to increase sales.
The officials allegedly concealed the way these deals were linked from the auditors, so they wouldn’t raise objections to them being recognized as revenue.
According to the civil complaint, Patel, Kirkpatrick and Barber detailed the structure of these deals in March of 2001 in a conference call that included Jaeger, Shanahan, Gagalis and Kay.
Despite auditors urging that such deals should be “collapsed,” when Cabletron was spinning off Enterasys, in August of that year, former Enterasys CEO Enrique Fiallo and Gagalis allegedly went to Patel and Jaeger, saying that they would not meet sales projections in that crucial quarter. Patel and Jaeger then directed the Enterasys officials to force more product through the channel “in the absence of legitimate revenue opportunities,” according to the complaint.
Afterwards, Jaeger and Gagalis oversaw an effort to purge the three-corner deal files linking purchases to investments, with Jaeger sending an e-mail to Gagalis to “crack the whip” to get the deals “cleaned up” and not to talk to auditors.
Other deals
While the complaint echoes the fraudulent transactions listed in criminal complaints, it also specifies numerous other deals that allegedly improperly inflated revenue, including:
• Jaeger negotiated a $250,000 reciprocal purchase agreement between Enterasys and Everest Broadband Networks, even though neither needed the other’s product.
• Jaeger, with Patel’s knowledge, entered into a $1 million arrangement with Cellit Inc., a software developer in Miami, even though the two companies didn’t need each others products.
• Skubisz used a side agreement with Wildflower International to hide parts of a deal that would prevent have prevented some $360,000 to be recognized.
• Kirkpatrick prepared a secret memo that would give SG Cowen, an international investment bank, full exchange rights on Aprisma product, yet recorded the deal as a sure sale.
• Shanahan was involved with an undisclosed verbal side agreement with GovStreetUSA, a Florida-based reseller of information technology products, in which Cabletron, and then Enterasys, would agree to resell some $2.6 million allegedly sold to them.
• Kirkpatrick and Kay agreed to invest in financially unstable Muzicom so it would buy about a half million dollars of Cabletron’s product.
• Barber worked out a $2 million deal with HealthCite, even though it was a start-up company that could not buy Cabletron products without the investment. Since HealthCite couldn’t warehouse the product, it was shipped to a third-party distributor, with a secret side agreement.
• Boey was involved in $3.1 million deal with ChoiceWay, in which Enterasys would use the investment to purchase its own product.
The complaint also briefly details 13 other previously undisclosed allegedly fraudulent transactions, including a deal directly involving Patel and Jaeger and a company called TrustWave.
In addition to unspecified fines, the complaint asks that the former executives return any “ill-gotten gains” their alleged conduct reaped. For Patel, it could amount to $1.2 million in bonuses and up to $5.2 million in stock sales. For Kirkpatrick, it would amount to $186,000 in bonuses and up to $5.4 million in stock sales. For Jaeger, it would amount to $700,000 in bonus and loan forgiveness and $2.6 million in gains from stock sales.
Fiallo settlement
In a separate action, the SEC filed complaints against four (and settled with at least three) former witnesses in the criminal trial, all of whom had previously pleaded guilty to securities fraud and would be expected to testify in the civil case.
The most recent settlement - filed on Feb. 9 -- was reached with Fiallo, a former Enterasys CEO. In the agreement, Fiallo would agree not to contest the charges, many of which are the same as those against the other 10 defendants, and to testify if needed.
He agreed to pay an unspecified amount - to be decided by the U.S. District Court in Concord.
A similar complaint against Fiallo’s executive assistant, Gayle Spence, also was filed, but no settlement was available as of NHBR Daily deadline.
Craig Benson, Cabletron co-founder and Patel’s predecessor, was not charged in the complaint, or any other federal action, though he had been named personally in a class action suit against Cabletron that also alleges revenue inflation, though that suit pertains to a much earlier time period. That suit was eventually settled.
Benson, who served with many of those involved, stepped down as Cabletron CEO in June 1999 before the alleged conspiracy began. But at the time Benson was a board member and the largest stockholder in the company. And when Enterasys was spun off, Benson headed the board’s audit committee. Almost all of the alleged conspirators previously worked under Benson, and Skubisz served on his transition team when Benson was elected to serve as New Hampshire governor in 2002.
Benson also picked Patel as his successor shortly after Cabletron acquired a California company Patel founded. Patel - with Benson’s support - later engineered Cabletron’s split into four companies, including Enterasy, Aprisma and Riverstone Networks.
Patel went on to chair the board of Riverstone, which moved to California, went bankrupt and sold its assets to Lucent Technologies about a year ago. The SEC recently filed charges against six former Riverstone executives who also date back to Cabletron, including Riverstone’s former CEO and CFO. Patel was not named in that complaint. - BOB SANDERS

This article appears in the February 2 2007 issue of New Hampshire Business Review